Feature: How to Avoid Costly Disputes in Option Agreements
By Chris Gaunt, senior associate in Rosling King’s property team
Commonly used between landowners and developers, an option agreement is implemented when a developer is considering purchasing a site for either residential and/or commercial development but wishes to apply for and secure the necessary planning permission required to proceed with the development before purchase.
An option agreement is not to be confused with a deed of pre-emption or right of first refusal as sometimes known, which is the right to be offered a property first, should the owner decide to dispose of it.
Option agreement can bring benefits for all parties if they are correctly laid out however, get them wrong and they can lead to all sorts of costly disputes. The top ten tips to bear in mind when drafting a successful option agreement contract include:
Option period – allow flexibility
An option period is the timeframe within which the developer can serve an option notice, requiring the landowner to sell the site to the developer. This can be for any length of time but tends to be negotiated dependent on the nature and scale of the proposed development. A period of three years for smaller sites is standard. With larger sites requiring a longer period to unlock development value, an option period of five to 10 years would not be unusual.
When negotiating and drafting an option period, always build in a degree of flexibility. Planning applications can be delayed for a variety of reasons and decisions can get challenged, so make sure the agreement makes allowance for this and provides a mechanism for extending the option period.
Price – minimise tensions
If a price cannot be agreed at the outset, negotiations over the price payable for the site can lead to arguments. This can largely be avoided by making provisions in the Option for the use of a standard RICS ‘red book’ valuation with a percentage discount from market value at the time of exercise of the option notice. Parties should ensure they include provision for determination by an independent expert in the event they are unable to come to an agreement.
Clear drafting to reduce costs
Make sure each party’s obligations are carefully recorded so as to avoid costly disputes at a later stage.
Consider the Overage
This is often required to allow landowners to share in future increases in value – consider how the overage will be secured, how will it be calculated, what will the trigger(s) be and what conditions need to be satisfied?
Be clear how each party may terminate the option agreement and include dispute resolution procedures in your option agreement.
If the landowner enters into an option agreement without lender consent, it may be in breach of the terms of its mortgage. This could result in the lender exercising its power of sale and taking free from the option agreement, which could mean the developer having spent time and money on obtaining a planning permission, yet not secured purchase of the site.
Consider carefully what rights need to be retained / granted over any land that the landowner is not selling so as to a) not detrimentally impact any future landowner development and b) not impinge on the implementation of the developer’s planning permission. Consider aspects such as access and drainage rights.
You may wish to consider looking to agree the wording of the option notice in advance and set it out in a schedule to the option agreement. The wording should be clear and unambiguous. One advantage of this approach is that it requires both parties to consider the option formalities in advance. The disadvantage (from a developer’s perspective) is that the terms of the agreed option notice would need to be complied with strictly to ensure the option is validly exercised.
Definition of property
The option should contain a clear and accurate description of the extent of the property that is subject to the option, as inaccuracy could lead to a dispute down the line.
Time is of the essence
Remember, time is of the essence for exercising an option notice and service of such notice must comply strictly with the time limits set out in the option agreement. Any pre-conditions to be fulfilled before exercise of the option must also be strictly complied with to avoid the option notice being construed as invalid.
A well-drafted option agreement can significantly minimise the risk of a venture for a developer. It also allows a landowner to benefit from potential increase in land value without being put to the cost and uncertainty of making their own planning application.